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Revisiting the ICAPM under the distortion of risk–return tradeoff in short‐horizon stock returns

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  • Surya Chelikani
  • Kiseok Nam
  • Xuewu Wesley Wang

Abstract

We suggest that the distortion of the positive risk–return relation in the ICAPM is a consequence of trading by informed investors to exploit mispricing. We hypothesize and demonstrate that a non‐positive (strongly positive) risk–return relation following positive (negative) market returns is attributed to short‐selling (purchasing) of overpriced (underpriced) stocks along with optimistic (pessimistic) expectations conditional on good (bad) market news. We verify this asymmetry in the risk–return relation through the indirect risk–return relation conditional on good (bad) market news. We also find that the attenuation (reinforcement) of the positive risk–return relation is more profound in high‐ (low‐) sentiment periods.

Suggested Citation

  • Surya Chelikani & Kiseok Nam & Xuewu Wesley Wang, 2023. "Revisiting the ICAPM under the distortion of risk–return tradeoff in short‐horizon stock returns," Review of Financial Economics, John Wiley & Sons, vol. 41(2), pages 109-135, April.
    • Handle: RePEc:wly:revfec:v:41:y:2023:i:2:p:109-135
    DOI: 10.1002/rfe.1169
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